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Interest Rates Must Rise So Inflation Can Sink, Says the Fed of .5% Hike

As widely predicted by analysts and journalists, and as telegraphed by the Fed itself, the Federal Reserve announced last week that it is raising interest rates by .5%, the highest rate hike in the last 22 years.

The .5% interest rate hike is meant to address the nation’s worst inflation in the last 40 years. Indeed, as Fed Chairman Jerome Powell said, “Inflation is much too high, and we understand the hardship this is causing. We are moving expeditiously to bring it back down.”

Once it starts coming down, the rate hikes will nonetheless continue. Indeed, the Fed further confirmed suspicions by pledging to continue interest rate hikes for the foreseeable future—as Powell told reporters, “If inflation comes down, we’re not going to stop [hiking rates], we’re just going to go down to 25 basis point increases.”

Though they reserve the right to put in another .5% increase, if necessary, they will at the very least be putting in another .25% (25 basis points) hike. Any way this goes, interest rates will increase in June.

compliance federal reserve

Yet, whatever the conditions, it seems unlikely these incremental hikes will increase beyond .5%: “A 75 basis point increase is not something the committee is actively considering,” Powell said.

Interest Rates, Worker Wages, and Inflation

Interest rate hikes should, overtime, put downward pressure on consumer demand. With higher interest rates, it becomes more expensive to borrow money to buy a home, a car, or anything else that requires financing. This will delay some purchases; it will obviate others.

As these large purchases decrease, so too does the economy supporting them.

Think of it this way: if car sales decrease as interest rates rise, it’s not just car manufacturers themselves who will feel the downturn. It’s also raw materials exporters, the microchip producers, the people who make the sound system, the people who make glass, the people contracted to do the marketing.

It takes a village to raise a child and it takes a global economy to make a car.

compliance manufacturing car

And as car sales decrease, so too will the demand on all these industries, leading to increased competition over dwindling demand, thereby decreasing inflation.

Similarly, as we discussed in a previous employer compliance blog, the Fed also hopes the interest rate hike will depress wages, another key contributor to inflation.

…But What About War and COVID?

Of course, inflation is not merely a national issue, it is a global one. That means that controlling inflation and its domestic effects is not exclusively or entirely in the Fed’s hands. For example, Russia’s invasion of Ukraine has depleted energy and food supplies alike, shrinking supply and sparking inflation.

compliance manufacturing microchip

Similarly, COVID-19 related lockdowns in China slow industrial production and consumption, again limiting supply and causing prices to rise.

So, interest rates must rise. But if the goal is to decrease the economic pressure inflation puts on consumers, well, let’s just say consumers are about to find a new set of problems. As one economist bluntly observed, "Your credit card debt is going to get more expensive in a hurry, and it's not going to stop anytime soon.”

We don’t envy the Fed. Balancing housing, labor, consumer, and credit imperatives—that kind of economic engineering is incredibly difficult…and that’s without a war in the global breadbasket and a lockdown in the world’s biggest economy.

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